BILL ANALYSIS Ó SB 1226 Page 1 Date of Hearing: June 28, 2016 ASSEMBLY COMMITTEE ON HUMAN SERVICES Susan Bonilla, Chair SB 1226 (Beall) - As Amended March 28, 2016 SENATE VOTE: 39-0 SUBJECT: Regional centers: audits and reviews SUMMARY: Requires regional centers to submit, and the Department of Developmental Services (DDS) to review and report on, all vendor independent audit reports. Specifically, this bill: 1)Requires a regional center to submit copies of all independent audit reports received to the DDS for review. 2)Requires DDS to analyze independent audit reports submitted by regional centers to determine if they are effective in preventing fraud and improving accounting practices among entities that receive regional center funding and further requires DDS to report its findings to the Legislature on a biannual basis, as specified. SB 1226 Page 2 EXISTING LAW: 1)Establishes the Lanterman Developmental Disabilities Services Act (Lanterman Act), providing an entitlement to services for individuals with developmental disabilities. (WIC 4500 et seq.) 2)Grants all individuals with developmental disabilities, among all other rights and responsibilities established for any individual by the United States Constitution and laws and the California Constitution and laws, a number of rights, including the right to treatment and habilitation services and supports in the least restrictive environment. (WIC 4502) 3)Establishes a system of nonprofit regional centers throughout the state to identify needs and coordinate services for eligible individuals with developmental disabilities and requires DDS to contract with regional centers to provide case management services and arrange for or purchase services that meet the needs of individuals with developmental disabilities, as defined. (WIC 4620 et seq.) 4)Requires the development of an individual program plan (IPP) for each regional center consumer, which specifies services to be provided to the consumer, based on his or her individualized needs determination and preferences, and defines that planning process as the vehicle to ensure that services and supports are customized to meet the needs of consumers who are served by regional centers. (WIC 4512) SB 1226 Page 3 5)Creates a process by which regional centers may "vendorize" service providers, thereby providing a path to contract for services with that provider and ensuring maximum flexibility and availability of appropriate services and support for persons with developmental disabilities. (WIC 4648) 6)Authorizes regional centers to solicit an individual or agency through a request for proposals or other means to provide needed services or supports not presently available, provided it is necessary to expand the availability of needed services of good quality. (WIC 4648(e)(1)) 7)Requires regional centers to provide the consumer, his or her parent, legal guardian, or other appropriate authorized representative, as specified, at least annually, a statement of services and supports the regional center purchased, for the purpose of ensuring that the services are delivered. (WIC 4648(h)) 8)Authorizes DDS and regional centers to monitor services and supports purchased for regional center consumers without prior notice, as specified, and authorizes DDS to conduct fiscal reviews and audits of service providers' records. (WIC 4648.1(a)) 9)Requires that DDS and regional center staff involved in monitoring or auditing services provided to regional center consumers be granted access to a provider's grounds, buildings, service program, and all related records and documentation, as specified. (WIC 4648.1(b)) SB 1226 Page 4 10)Requires that an entity receiving payments from one or more regional centers contract with an independent accounting firm for an audit or review of its financial statements subject to all of the following: a) When the amount received from the regional center or regional centers during the entity's fiscal year is more than or equal to $500,000 but less than $2 million, the entity shall obtain an independent review report of its financial statements for the period. This includes work activity program providers receiving less than $500,000, as specified; and b) When the amount received from the regional center or regional centers during the entity's fiscal year is equal to or more than $2 million, the entity shall obtain an independent audit of its financial statements for the period. (WIC 4652.5 (a)(1)) 11)Excludes certain payment types, as specified, from consideration and exempts state and local governmental agencies, the UC and CSU university systems from the audit and review requirements. (WIC 4652.5(a)(2) and (a)(3)) 12)Requires vendors to provide copies of the independent audit or review reports, and accompanying management letters, to the vendoring regional center within nine months of the end of the vendor's fiscal year. (WIC 4652.5(b)) 13)Requires regional centers to review the audit and review reports and require resolution of issues identified in the report that have an impact on regional center services, and to take appropriate action, which may entail termination of vendorization, for lack of adequate resolution of issues. (WIC 4652.5(c)) 14)Requires regional centers to notify DDS of all qualified SB 1226 Page 5 opinion reports or reports noting significant issues that directly or indirectly impact regional center services within 30 days after receipt, and requires the notification to include a plan for resolution of issues. (WIC 4652.5 (d)) 15)Specifies that an independent review of financial statements must be performed by an independent accounting firm and requires the review to include, at a minimum: a) An inquiry as to the entity's accounting principles and practices and methods used in applying them; b) An inquiry as to the entity's procedures for recording, classifying, and summarizing transactions and accumulating information; c) Analytical procedures designed to identify relationships or items that appear to be unusual; d) An inquiry about budgetary actions taken at meetings of the board of directors or other comparable meetings; e) An inquiry about whether the financial statements have been properly prepared in conformity with generally accepted accounting principles and whether any events subsequent to the date of the financial statements would have a material effect on the statements under review; and f) Working papers prepared in connection with a review of financial statements describing the items covered as well as any unusual items, including their disposition. (WIC 4652.5(e)) 16)Specifies that the independent review report shall cover, at a minimum, all of the following: a) Certification that the review was performed in accordance with standards established by the American Institute of Certified Public Accountants; SB 1226 Page 6 b) Certification that the statements are the representations of management; c) Certification that the review consisted of inquiries and analytical procedures that are lesser in scope than those of an audit; and d) Certification that the accountant is not aware of any material modifications that need to be made to the statements for them to be in conformity with generally accepted accounting principles. (WIC 4652.5(f)) 17)Prohibits DDS from considering requests for adjustments to rates submitted by an entity receiving regional center payments solely to fund either anticipated or unanticipated changes required for an entity to comply with the audit or review requirements, as specified. (WIC 4652.5(g)) 18)Requires every charitable corporation, unincorporated association, and trustee required to file reports with the Attorney General, as defined, that receives or accrues in any fiscal year gross revenue of two million dollars ($2,000,000) or more, exclusive of grants from, and contracts for services with, governmental entities for which the governmental entity requires an accounting of the funds received, to obtain an annual financial audit, as defined, and requires the audited financial statements to be available for public inspection no later than nine months after the close of the fiscal year to which the statements relate, as defined. (GOV 12586 (e)(1)) 19)Requires a regional center to audit records of service providers, as specified, to the extent the regional center determines it is necessary. (California Code of Regulations Title 17 §50606) FISCAL EFFECT: According to the April 25, 2016, Senate SB 1226 Page 7 Appropriations Committee analysis, this bill may result in ongoing costs of $110,000 per year for an additional auditor position at DDS to review audit reports and report to the Legislature (70% General Fund, 30% federal funds). COMMENTS: Developmental services: Developmental disabilities are disabilities that originate before an individual attains 18 years of age and that are expected to continue indefinitely as a substantial disability for that individual. Developmental disabilities include intellectual disabilities, cerebral palsy, epilepsy, and autism spectrum disorders, as well as those disabling conditions similar to an intellectual disability that require care and management similar to that required by individuals with an intellectual disability. Guidance for the delivery of services and supports to Californians with developmental disabilities is found in the Lanterman Act (WIC § 4500 et seq.). This Act entitles individuals with developmental disabilities (often referred to as "consumers") to treatment and habilitation services and supports in the least restrictive environment; services are designed to enable all consumers to live more independent and productive lives in the community. The developmental services system is administered by DDS and a network of 21 regional centers across the state, which are private nonprofit entities established pursuant to the Lanterman SB 1226 Page 8 Act, that contract with DDS to carry out many of the state's responsibilities under the Act. These 21 regional centers serve over 300,000 consumers, providing services such as residential placements, supported living services, respite care, transportation, day treatment programs, work support programs, and various social and therapeutic activities. Another approximately 980 consumers live at one of California's three Developmental Centers-and one state-operated, specialized community facility-which provide 24-hour habilitation and medical and social treatment services. Individuals with developmental disabilities receive services that are outlined in an individual program plan (IPP) which is based on that individual's needs and choices and is developed by an IPP team that includes, among other individuals, the consumer, his or her legally authorized representative, and one or more representatives from the regional center. The Lanterman Act requires that the IPP promote community integration and maximize opportunities for each consumer to develop relationships, be part of community life, increase control over his or her life, and acquire increasingly positive roles in the community. The IPP must prioritize those services and supports that allow minors to live with their families and adults to live as independently as possible in the community. Vendorization of community-based services: The 21 regional centers receive an operations budget from DDS to carry out activities related to eligibility determination and development of IPPs. Regional centers also receive funds to purchase over 150 different types of services from vendors; services and supports are aimed at supporting individuals to live in the SB 1226 Page 9 community and can include in-home care, housing, transportation, activity programs, and employment programs. (Regional centers are the payer of last resort and therefore typically pay for services only in instances where a consumer does not have private health insurance or cannot be referred to "generic" services; the majority of regional center consumers are enrolled in Medi-Cal.) "Vendorization" is the process by which service providers are identified, selected, and utilized, based on qualifications and requirements, to provide services to consumers. Through this process, regional centers are able to verify that an applicant vendor complies with all necessary requirements and regulations prior to providing services; the regional center with the catchment area in which the service is located vendors that services provider. The vendoring regional center is then responsible for verifying that the applicant vendor meets all necessary licensing, and other, requirements; the regional center will also determine the appropriate vendor category for the service to be provided. If an applicant meets all necessary requirements, a regional center is required to vendor that applicant - however, this does not obligate the regional center to purchase services from that vendor. Other regional centers are also able to utilize the services of a provider vendored by another regional center. There are currently over 44,000 vendors that provide services paid for by regional centers in California. Vendor audits and reviews: In August 2010, the California State Auditor's Office released a report entitled, "Department of Developmental Services: A More Uniform and Transparent SB 1226 Page 10 Procurement and Rate-Setting Process Would Improve the Cost-Effectiveness of Regional Centers." This report found, among other things, that regional centers were not appropriately monitoring expenditures of vendors and that they did not always document why certain vendors were selected, how rates were set, or how contracts were procured. This report brought about heightened interest in oversight of vendor expenditures. SB 74 (Senate Committee on Budget and Fiscal Review), Chapter 9, Statutes of 2011, adopted, among other things, audit requirements for regional center vendors. Those vendors receiving between $250,000 and $499,999 in annual regional center funding were required to obtain an independent audit or independent review report of their financial statements for the fiscal year, with some exceptions. Those vendors receiving $500,000 or more annually did not have the option of submitting to a less-stringent independent review and instead were required to obtain an independent audit report. These new audit and review requirements were envisioned to bring about savings (approximately 1% of regional center purchase of service costs) due to the identification, and correction of, poor billing practices and inappropriate spending of regional center funds; DDS also indicated that these new requirements enabled the department to prioritize its own audits, focusing on those vendors who had issues needing addressed. Recent legislation - ABX2 1 (Thurmond), Chapter 3, Statutes of 2016 - changed some of these audit and review requirements. In June 2015, the Governor convened a special legislative session to address, among other things, funding rate increases for community service providers of services for individuals with developmental disabilities. One result of that special session was the passage of ABX2 1, signed by the Governor on March 1 of this year, which appropriated $287 million General Fund to regional centers and community services providers in 2016-17 in additional to leveraging an estimated $186 million in federal funding. Among the changes adopted by this bill were changes to vendor audit requirements. ABX2 1 raised the dollar thresholds triggering reviews and audits, and removed the option for SB 1226 Page 11 vendors in the lower tier to obtain independent audits, instead only requiring independent review reports; now, those vendors receiving between $500,000 and less than $2 million in annual regional center funding are required to obtain an independent review report, and those vendors receiving $2 million or more annually must obtain an independent audit report (these vendors are also now able to apply for a two-year exemption from the audit requirement). The 2016-17 State Budget includes $1.0 million ($0.7 million of which is General Fund) to permanently establish within DDS and retain funding for seven limited-term auditor positions in the Vendor Audit Section. While independent review reports are similar to audits, they are substantially smaller in scope and do not result in an opinion being issued; the purpose of the review is to analyze an organization's financial data and gather information from its management in order to express limited assurances that the organization is in conformity with Generally Acceptable Accounting Principles (GAAP). The review results in a Certified Public Accountant either issuing a clean report or issuing no report due to needed modifications. Audit reports are completed by independent accounting professionals in order to assess the financial status and stability of an organization, and whether financial records have been maintained in accordance with GAAP. An audit can result in any one of the following opinions: a) An unqualified opinion, also known as a "clean" or "unmodified" opinion, is the best possible opinion to receive as the result of an audit. It is issued when it has been determined that an organization's financial records are presented fairly and free of any misrepresentations; this type of opinion also indicates that the financial records have been maintained in accordance with GAAP; SB 1226 Page 12 b) A qualified opinion is issued when no misrepresentations are identified, but an organization's financial records have not been maintained in accordance with GAAP; this type of opinion indicates the reason that the audit report is not unqualified; c) An adverse opinion is issued when it is determined that the audited financial statements do not fairly represent the organization's financial position and do not adhere to the GAAP. Often, an auditor will work with the organization to resolve or correct issues so the published audit opinion can be either qualified or unqualified; or d) A disclaimer of opinion is provided when an auditor chooses not to issue an opinion, due to significant uncertainties in the appropriateness of the materials, significant limitations in the scope of the audit, or if the auditor feels he or she cannot complete an impartial or independent audit of the organization. According to a survey conducted by the Association of Regional Center Agencies (ARCA) in April 2015, an average of 52% of vendors complied with audit requirements; of those complying, 99% had unqualified opinions. According to the sponsors of this bill, financial review costs can range from $2,000 to $4,000, while the cost for impacted vendors to have an audit conducted is often between $6,000 and $14,000. Need for this bill: According to the author, "[This bill] helps address a primary concern about the SB 74 audit requirements- they are a burdensome cost to vendors and are not an effective way to identify fraud. Because the cost to perform audits and financial reviews are borne by vendors and reducing fraud is important, it is critical for the Legislature to understand if the audits are accomplishing what they were intended to do or if they are a waste of money. With [this bill], vendors can focus on providing core services to those in need." SB 1226 Page 13 ResCoalition, the sponsor of this bill, states that: "The Department of Developmental Services (DDS) passed a trailer bill as part of SB 74, labeled RC audits. In public testimony, DDS indicated this was in an effort to remedy the concerns of a Bureau of State Audits (BSA) audit of the Regional Center (RC) system that found a number of deficiencies. However the BSA audit was of RC's, not vendors and there was no recommendation that vendors get audited. Despite this, the measure passed with vendor audits included and a new, costly and confusing audit process is burdening the system with little or no redeeming value. While we have been successful in making some changes via ABX2 1, significant concerns still exist. Some issues with the above requirements include: Thresholds do not meet industry standards; Small vendors have been pushed into the next threshold with just the minimum wage increase and/or the return of the 4.25% temporary funding cut; Ignores normal and typical business practices of small SB 1226 Page 14 business, not accrual basis; Consequences vary between each RC; and Prohibitive costs to implement but no tangible outcomes. [This bill] seeks to get the Department of Developmental Services to assess the effectiveness of the continued mandate for fiscal audits, considering the department has acknowledged they have not achieved the intended or desired outcomes." Opposition: Writing in opposition to the bill, DDS states the following: "[This bill] would require that a regional center submit to DDS all service provider independent audit reports it receives for DDS' analysis and determination of whether the audits are effective in preventing fraud and improving service provider accounting practices. The bill would require DDS to report its findings to the Legislature twice per year. The independent audits required by statute, however, are not intended to detect fraud and the reports that DDS would be required to review do not include sufficient information to determine if the audits are effective in reducing fraud or improving accounting practices. An audit report is completed by an independent account SB 1226 Page 15 professional to express an opinion on the financial statements of a business or company. It considers a company's assets and liabilities, and reviews whether financial records have been maintained in accordance with General Accepted Accounting Principles (GAAP). Independent audits test and evaluate internal controls but are not designed to find or even prevent fraud. Consequently, if the reported figures were apparently correct, an independent auditor could issue a clean, 'Unqualified Audit Opinion,' despite the existence of fraud. The scope of an independent review is substantially less than that of an independent audit and can only provide 'limited assurance,' and no opinion is expressed by the reviewer regarding the financial statements. A review includes primarily applying analytical procedures to management's financial data and making inquiries of management; it does not include review of supporting evidence or the evaluation of internal controls. The purpose of [this bill] is to enable the Legislature to understand if audits are effective in reducing fraud and improving account practices. Because of the nature of independent audits, however, DDS would be unable to provide the Legislature with the information needed to accomplish this goal." Staff comments: DDS is not able to track the impact of the audit and review requirements on cost savings to the state, nor, per the department's opposition to this bill, are the audits able to be used to detect fraud. The limited scope of, and benefits resulting from, these audits and reviews does raise questions about their usefulness. However, this is not an argument for completely eliminating what current transparency and oversight do exist. Instead, the committee may wish to, as discussions around rate-setting and rate methodologies continue between the Legislature and the Administration, examine approaches to improving audit standards for developmental services in a way that enhances the usefulness of the results SB 1226 Page 16 and transparency and efficiency of the developmental services system. Recommended amendments: DDS states that it is impossible to detect fraud using the current audit reports, which were not designed for this purpose. In order to ensure that reporting responsibilities required of the department are achievable, and to acquire a statewide picture of the compliance with audit requirements and results of the audits and make this publicly available via DDS's performance dashboard, committee staff recommends the following amendments starting on line 34 of page 3 of the bill: 34 (2)A regional center shall submit copies of all independent 35 audit reports that it receives to the department for review. The 36 department shall compile data, by regional center, on vendor compliance with audit requirements and opinions resulting from audit reports and shall annuallyanalyze the reports to determine if they are37effective in preventing fraud and improving accounting practices38 SB 1226 Page 17among entities that receive payments from one or more regional39centers. The department shall biannually reportpublish these data in the performance dashboard pursuant to Section 4572.its findings to theP4 1Legislature. These reports shall be submitted pursuant to Section29795 of the Government Code.In order to more readily identify vendors that must submit review or audit reports, and to facilitate consistency in submission of those reports, committee staff also recommends amending the bill to: 1) specify that, as of January 1, 2018, the amount of money a vendor receives from a regional center in the state's, versus an entity's, fiscal year shall be used to determine if a vendor needs to submit a review or audit report; and 2) require, as of January 1, 2018, review and audit reports to be submitted to the vendoring regional center within nine months of the end of the state fiscal year, versus the end of the entity's fiscal year. PRIOR LEGISLATION: ABX2 1 (Thurmond), Chapter 3, Statutes of 2016, among other things, raised the dollar thresholds triggering reviews and audits, respectively, and removed the option for vendors in the SB 1226 Page 18 lower tier to obtain independent audits, instead only requiring independent review reports. SB 490 (Beall), 2015, would have increased audit and financial review thresholds for regional center vendors. It was held on the Assembly Appropriations Committee suspense file. SB 74 (Committee on Budget and Fiscal Review) Chapter 9, Statutes of 2011, established vendor audit and review requirements, among other provisions. REGISTERED SUPPORT / OPPOSITION: Support The ResCoalition, sponsor The Alliance Opposition Department of Developmental Services (DDS) Analysis Prepared by:Daphne Hunt / HUM. S. / (916) SB 1226 Page 19 319-2089